All assets acquired and liabilities assumed in the combination are recognized and measured at their individual fair values with few exceptions.. Any excess of the fair value of the consi
Trang 1CHAPTER 2 CONSOLIDATION OF FINANCIAL INFORMATION
Accounting standards for business combination are found in FASB ASC Topic 805, “Business Combinations” and Topic 810, “Consolidation.” These standards require the acquisition method which emphasizes acquisition-date fair values for recording all combinations
In this chapter, we first provide coverage of expansion through corporate takeovers and an overview of the consolidation process Then we present the acquisition method of accounting for business combinations followed by limited coverage of the purchase method and pooling of interests provided in the Appendix to this chapter
Chapter Outline
A A business combination is the formation of a single economic entity, an event that occurs whenever one company gains control over another
B Business combinations can be created in several different ways
1 Statutory merger—only one of the original companies remains in business as a legally incorporated enterprise
a Assets and liabilities can be acquired with the seller then dissolving itself as a corporation
b All of the capital stock of a company can be acquired with the assets and liabilities then transferred to the buyer followed by the seller’s dissolution
2 Statutory consolidation—assets or capital stock of two or more companies are transferred to a newly formed corporation
3 Acquisition by one company of a controlling interest in the voting stock of a second Dissolution does not take place; both parties retain their separate legal incorporation
C Financial information from the members of a business combination must be consolidated into a single set of financial statements representing the entire economic entity
1 If the acquired company is legally dissolved, a permanent consolidation is produced on the date of acquisition by entering all account balances into the financial records of the surviving company
2 If separate incorporation is maintained, consolidation is periodically simulated whenever financial statements are to be prepared This process is carried out through the use of worksheets and consolidation entries Consolidation worksheet entries are used to adjust and eliminate subsidiary company accounts Entry “S” eliminates the equity accounts of the subsidiary Entry “A” allocates exess payment amounts to identifiable assets and liabilities based on the fair value of the subsidiary accounts (Consolidation journal entries are never recorded in the books of either company, they are worksheet entries only.)
Trang 2II The Acquisition Method
A The acquisition method replaced the purchase method For combinations resulting in complete ownership, it is distinguished by four characteristics
1 All assets acquired and liabilities assumed in the combination are recognized and measured at their individual fair values (with few exceptions)
2 The fair value of the consideration transferred provides a starting point for valuing and recording a business combination
a The consideration transferred includes cash, securities, and contingent performance obligations
b Direct combination costs are expensed as incurred
c Stock issuance costs are recorded as a reduction in paid-in capital
d The fair value of any noncontrolling interest also adds to the valuation of the acquired firm and is covered beginning in Chapter 4 of the text
3 Any excess of the fair value of the consideration transferred over the net amount assigned to the individual assets acquired and liabilities assumed is recognized by the acquirer as goodwill
4 Any excess of the net amount assigned to the individual assets acquired and liabilities assumed over the fair value of the consideration transferred is recognized by the acquirer as a “gain on bargain purchase.”
B In-process research and development acquired in a business combination is recognized as an asset at its acquisition-date fair value
A IFRS 3 – nearly identical to U.S GAAP because of joint efforts
B IFRS 10 – Consolidated Finanical Statements and IFRS 12 – Disclosure of Interests
in Other Entities both become effective in 2013 Some differences between these and GAAP
APPENDIX:
The Purchase Method
A The purchase method was applicable for business combinations occurring for fiscal years beginning prior to December 15, 2008 It was distinguished by three characteristics
1 One company was clearly in a dominant role as the purchasing party
2 A bargained exchange transaction took place to obtain control over the second company
3 A historical cost figure was determined based on the acquisition price paid
a The cost of the acquisition included any direct combination costs
b Stock issuance costs were recorded as a reduction in paid-in capital and are not considered to be a component of the acquisition price
B Purchase method procedures
1 The assets and liabilities acquired were measured by the buyer at fair value as of the date of acquisition
2 Any portion of the payment made in excess of the fair value of these assets and liabilities was attributed to an intangible asset commonly referred to as goodwill
Trang 33 If the price paid was below the fair value of the assets and liabilities, the accounts
of the acquired company were still measured at fair value except that the values of certain noncurrent assets were reduced in total by the excess cost If these values were not great enough to absorb the entire reduction, an extraordinary gain was recognized
The Pooling of Interest Method (prohibited for combinations after June 2002)
A A pooling of interests was formed by the uniting of the ownership interests of two companies through the exchange of equity securities The characteristics of a pooling are fundamentally different from either the purchase or acquisition methods
1 Neither party was truly viewed as an acquiring company
2 Precise cost figures stemming from the exchange of securities were difficult to ascertain
3 The transaction affected the stockholders rather than the companies
B Pooling of interests accounting
1 Because of the nature of a pooling, determination of an acquisition price was not relevant
a Since no acquisition price was computed, all direct costs of creating the combination were expensed immediately
b In addition, new goodwill arising from the combination was never recognized
in a pooling of interests Similarly, no valuation adjustments were recorded for any of the assets or liabilities combined
2 The book values of the two companies were simply brought together to produce a set of consolidated financial records A pooling was viewed as affecting the owners rather than the two companies
3 The results of operations reported by both parties were combined on a retroactive basis as if the companies had always been together
4 Controversy historically surrounded the pooling of interests method
a Any cost figures indicated by the exchange transaction that created the combination were ignored
b Income balances previously reported were altered since operations were combined on a retroactive basis
c Reported net income was usually higher in subsequent years than in a purchase since no goodwill or valuation adjustments were recognized which require amortization
Trang 4Answers to Questions
1 A business combination is the process of forming a single economic entity by the uniting
of two or more organizations under common ownership The term also refers to the entity that results from this process
2 (1) A statutory merger is created whenever two or more companies come together to
form a business combination and only one remains in existence as an identifiable entity This arrangement is often instituted by the acquisition of substantially all of an enterprise’s assets (2) A statutory merger can also be produced by the acquisition of a company’s capital stock This transaction is labeled a statutory merger if the acquired company transfers its assets and liabilities to the buyer and then legally dissolves as a corporation (3) A statutory consolidation results when two or more companies transfer all of their assets or capital stock to a newly formed corporation The original companies are being “consolidated” into the new entity (4) A business combination is also formed whenever one company gains control over another through the acquisition of outstanding voting stock Both companies retain their separate legal identities although the common ownership indicates that only a single economic entity exists
more separate companies This data, although accumulated individually by the organizations, is brought together (or consolidated) to describe the single economic entity created by the business combination
4 Companies that form a business combination will often retain their separate legal
identities as well as their individual accounting systems In such cases, internal financial data continues to be accumulated by each organization Separate financial reports may
be required for outside shareholders (a noncontrolling interest), the government, debt holders, etc This information may also be utilized in corporate evaluations and other decision making However, the business combination must periodically produce consolidated financial statements encompassing all of the companies within the single economic entity The purpose of a worksheet is to organize and structure this process The worksheet allows for a simulated consolidation to be carried out on a regular, periodic basis without affecting the financial records of the various component companies
5 Several situations can occur in which the fair value of the 50,000 shares being issued
might be difficult to ascertain These examples include:
The shares may be newly issued (if Jones has just been created) so that no accurate value has yet been established;
Jones may be a closely held corporation so that no fair value is available for its shares;
The number of newly issued shares (especially if the amount is large in comparison to the quantity of previously outstanding shares) may cause the price of the stock to fluctuate widely so that no accurate fair value can be determined during a reasonable period of time;
Jones’ stock may have historically experienced drastic swings in price Thus, a quoted figure at any specific point in time may not be an adequate or representative value for long-term accounting purposes
6 For combinations resulting in complete ownership, the acquisition method allocates the
fair value of the consideration transferred to the separately recognized assets acquired and liabilities assumed based on their individual fair values
Trang 57 The revenues and expenses (both current and past) of the parent are included within
reported figures However, the revenues and expenses of the subsidiary are consolidated from the date of the acquisition forward within the worksheet consolidation process The operations of the subsidiary are only applicable to the business combination if earned subsequent to its creation
8 Morgan’s additional acquisition value may be attributed to many factors: expected
synergies between Morgan’s and Jennings’ assets, favorable earnings projections, competitive bidding to acquire Jennings, etc In general however, any amount paid by the parent company in excess of the fair values of the subsidiary’s net assets acquired is reported as goodwill
9 In the vast majority of cases the assets acquired and liabilities assumed in a business
combination are recorded at their fair values If the fair value of the consideration transferred (including any contingent consideration) is less than the total net fair value assigned to the assets acquired and liabilities assumed, then an ordinary gain on bargain purchase is recognized for the difference
10 Shares issued are recorded at fair value as if the stock had been sold and the money
obtained used to acquire the subsidiary The Common Stock account is recorded at the par value of these shares with any excess amount attributed to additional paid-in capital
11 The direct combination costs of $98,000 are allocated to expense in the period in which
they occur Stock issue costs of $56,000 are treated as a reduction of APIC
Trang 714 C Value of shares issued (51,000 × $3) $153,000
Par value of shares issued (51,000 × $1) 51,000
Additional paid-in capital (new shares) $102,000
Additional paid-in capital (existing shares) 90,000
Consolidated additional paid-in capital (fair value) $192,000
At the acquisition date, the parent makes no change to retained earnings
15 B Consideration transferred (fair value) $400,000
Book value of subsidiary (assets minus liabilities) (300,000)
Fair value in excess of book value 100,000
Allocation of excess fair over book value
identified with specific accounts:
16 D TruData patented technology $230,000
Webstat patented technology (fair value) 200,000
Acquisition-date consolidated balance sheet amount $430,000
17 C TruData common stock before acquisition $300,000
Common stock issued (par value) 50,000
Acquisition-date consolidated balance sheet amount $350,000
18 B TruData’s 1/1 retained earnings $130,000
TruData’s income (1/1 to 7/1) 80,000
Acquisition-date consolidated balance sheet amount $210,000
19 a An intangible asset acquired in a business combination is recognized as an
asset apart from goodwill if it arises from contractual or other legal rights (regardless of whether those rights are transferable or separable from the acquired enterprise or from other rights and obligations) If an intangible asset does not arise from contractual or other legal rights, it shall be
recognized as an asset apart from goodwill only if it is separable, that is, it
is capable of being separated or divided from the acquired enterprise and sold, transferred, licensed, rented, or exchanged (regardless of whether there is an intent to do so) An intangible asset that cannot be sold,
transferred, licensed, rented, or exchanged individually is considered
separable if it can be sold, transferred, licensed, rented, or exchanged with
a related contract, asset, or liability
b Trademarks—usually meet both the separability and legal/contractual
criteria
Trang 8 Customer list—usually meets the separability criterion
Copyrights on artistic materials—usually meet both the separability and
legal/contractual criteria
Agreements to receive royalties on leased intellectual property—usually
meet the legal/contractual criterion
Unpatented technology—may meet the separability criterion if capable
of being sold even if in conjunction with a related contract, asset, or liability
20 (12 minutes) (Journal entries to record a merger—acquired company
Trang 922 (15 Minutes) (Consolidated balances)
In acquisitions, the fair values of the subsidiary's assets and liabilities are consolidated (there are a limited number of exceptions) Goodwill is reported
at $80,000, the amount that the $760,000 consideration transferred exceeds the
$680,000 fair value of Sol’s net assets acquired
Inventory = $670,000 (Padre's book value plus Sol's fair value)
Land = $710,000 (Padre's book value plus Sol's fair value)
Buildings and equipment = $930,000 (Padre's book value plus Sol's fair value)
Franchise agreements = $440,000 (Padre's book value plus Sol's fair value)
Goodwill = $80,000 (calculated above)
Revenues = $960,000 (only parent company operational figures are
reported at date of acquisition)
Additional paid-in capital = $265,000 (Padre's book value adjusted for stock issue less stock issuance costs)
Expenses = $940,000 (only parent company operational figures plus acquisition-related costs are reported at date of acquisition)
Retained earnings, 1/1 = $390,000 (Padre's book value only)
Retained earnings, 12/31 = $410,000 (beginning retained earnings plus revenues minus expenses, of Padre only)
Trang 1023 (20 minutes) Journal entries for a merger using alternative values
a Acquisition date fair values:
Contingent performance liability 35,000
Fair values of net assets acquired 750,000
Contingent Performance Liability 35,000
Professional Services Expense 100,000
Contingent Performance Liability 35,000
Professional Services Expense 100,000
Trang 1124 (20 Minutes) (Determine selected consolidated balances)
Under the acquisition method, the shares issued by Wisconsin are recorded at fair value using the following journal entry:
Investment in Badger (value of debt and shares issued) 900,000
Common Stock (par value) 150,000 Additional Paid-In Capital (excess over par value) 450,000 Liabilities 300,000 The payment to the broker is accounted for as an expense The stock issue cost is a reduction in additional paid-in capital
Professional Services Expense 30,000
Additional Paid-In Capital 40,000
Cash 70,000
Allocation of Acquisition-Date Excess Fair Value:
Consideration transferred (fair value) for Badger Stock $900,000 Book Value of Badger, 6/30 770,000 Fair Value in Excess of Book Value $130,000 Excess fair value (undervalued equipment) 100,000 Excess fair value (overvalued patented technology) (20,000) Goodwill $ 50,000
CONSOLIDATED BALANCES:
Net income (adjusted for professional services expense The
figures earned by the subsidiary prior to the takeover
are not included) $ 210,000
Retained earnings, 1/1 (the figures earned by the subsidiary
prior to the takeover are not included) 800,000
Patented technology (the parent's book value plus the fair
value of the subsidiary) 1,180,000
Goodwill (computed above) 50,000
Liabilities (the parent's book value plus the fair value
of the subsidiary's debt plus the debt issued by the parent
in acquiring the subsidiary) 1,210,000
Common stock (the parent's book value after recording
the newly-issued shares) 510,000
Additional Paid-in Capital (the parent's book value
after recording the two entries above) 680,000
Trang 1225 (20 minutes) (Preparation of a consolidated balance sheet)*
CASEY COMPANY AND CONSOLIDATED SUBSIDIARY KENNEDY
Worksheet for a Consolidated Balance Sheet
Total liab & equities (13,384,000) (5,943,000) 3,408,000 3,408,000 (16,727,000)
*Although this solution uses a worksheet to compute the consolidated amounts, the problem does not require it
26 (50 Minutes) (Determine consolidated balances for a bargain purchase.)
a Marshall’s acquisition of Tucker represents a bargain purchase because the fair value of the net assets acquired exceeds the fair value of the
consideration transferred as follows:
In a bargain purchase, the acquisition is recorded at the fair value of the net assets acquired instead of the fair value of the consideration
transferred (an exception to the general rule)
Prior to preparing a consolidation worksheet, Marshall records the three transactions that occurred to create the business combination
Investment in Tucker 515,000
Long-term Liabilities 200,000
Common Stock (par value) 20,000
Additional Paid-In Capital 180,000
Gain on Bargain Purchase 115,000
(To record liabilities and stock issued for Tucker acquisition fair value)
Trang 1326 (continued)
Professional Services Expense 30,000
Cash 30,000
(to record payment of professional fees)
Additional Paid-In Capital 12,000
Cash 12,000
(To record payment of stock issuance costs)
Marshall's trial balance is adjusted for these transactions (as shown in the worksheet that follows)
Next, the $400,000 fair value of the investment is allocated:
Consideration transferred at fair value $400,000
Book value (assets minus liabilities or
total stockholders' equity) 460,000
Book value in excess of consideration transferred (60,000)
Allocation to specific accounts based on fair value:
Inventory 5,000
Land 20,000
Buildings 30,000 55,000
Gain on bargain purchase (excess net asset fair value
over consideration transferred) $(115,000)
CONSOLIDATED TOTALS
Cash = $38,000 Add the two book values less acquisition and stock issue costs
Receivables = $360,000 Add the two book values
Inventory = $505,000 Add the two book values plus the fair value
adjustment
Land = $400,000 Add the two book values plus the fair value adjustment
Buildings = $670,000 Add the two book values plus the fair value
adjustment
Equipment = $210,000 Add the two book values
Total assets = $2,183,000 Summation of the above individual figures
Accounts payable = $190,000 Add the two book values
Long-term liabilities = $830,000 Add the two book values plus the debt incurred by the parent in acquiring the subsidiary
Common stock = $130,000.The parent's book value after stock issue to acquire the subsidiary
Additional paid-in capital = $528,000.The parent's book value after the stock issue to acquire the subsidiary less the stock issue costs
Retained earnings = $505,000 Parent company balance less $30,000 in professional services expense plus $115,000 gain on bargain purchase
Total liabilities and equity = $2,183,000 Summation of the above figures
Trang 1426 (continued)
Worksheet January 1, 2015
Marshall Tucker Consolidation Entries Consolidated
Total liab and owners’ equity (1,943,000) (700,000) 515,000 515,000 (2,183,000)
Marshall's accounts have been adjusted for acquisition entries (see part a.)